The ADX (Average Directional Index)/ DMS (Directional Movement System) indicator measures the strength of a trend and can be useful to determine if a trend is strong or weak. High readings indicate a strong trend and low readings indicate a weak trend.
When this indicator is showing a low reading then a trading range is likely to develop. Avoid stocks with low readings! You want to be in stocks that have high readings.
This indicator uses three inputs to analyse the strength and direction of a price trend. It was originally devised by Welles Wilder.
The three inputs are the Average Directional Index (ADX), the Minus Directional Indicator (-DI) and the Plus Directional Indicator (+DI). The first of these measures the strength of a trend, regardless of direction. The second two measure the direction of the trend.
Note: This indicator measures strong or weak trends. This can be either a strong uptrend or a strong downtrend. It does not tell you if the trend is up or down, it just tells you how strong the current trend is!
By default the ADX is calculated by taking the 14-day moving averages of the +DI and -DI values. ADX/DMS period length and line colours can be adjusted in the settings modal.
The ADX/DMS indicator consists of 3 components.
- The +DI or PDI line – shown on green colour.
- The -DI or MDI line – shown on red colour.
- The ADX line – shown on black colour.
The PDI and MDI lines gives buy and sell signals and the ADX/DMS line shows the trend strength.
In the chart above, the ADX indicator is the thick black line. The other lines are the +DI and -DI (ignore these). when it is showing a low reading and the stock is chopping around sideways.
If the indicator gets into higher territory. A strong trend develops! These are the type of stocks that you want to trade.
On the right side of the indicator panel you will see a scale from 0 to 100 (only 0 through 80 are marked).
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ADX indicator scale
If ADX is between 0 and 25 then the stock is in a trading range. It is likely just chopping around sideways. Avoid these weak, pathetic stocks!
Once ADX gets above 25 then you will begin to see the beginning of a trend. Big moves (up or down) tend to happen when ADX is right around this number.
When the ADX indicator gets above 30 then you are staring at a stock that is in a strong trend! These are the stocks that you want to be trading!
You won’t see very many stocks with the ADX above 50. Once it gets that high, you start to see trends coming to an end and trading ranges developing again.
So what is the ADX indicator good for?
This indicator is best used for screening stocks and writing scans. By adding this indicator to your scanning software, you can eliminate all of the stocks that are in trading ranges. You can then set up your scan to find only those stocks that are in strong up trends or strong down trends.
This indicator does not give buy or sell signals. It does, however, give you some perspective on where the stock is in the trend. Low readings and you have a trading range or the beginning of a trend. Extremely high readings tell you that the trend will likely come to an end.